Purchasing 2nd home, apply for heloc or use cash for downpayment

[Maggie Thompson]

I am a newbie with BP, so apologies in advance for my questions. I've searched around, but need some guidance for my specific situation. 

Scenario: Looking to buy a primary residence house $360-380K. Rent out a room to help with mortgage, possibly rent out entire house down the road. I have a condo with about $120K in equity at 3.65% interest rate. I refinanced 2 years ago, so trying to avoid any more costs to refinance. I would have enough for 20% down in cash, but I'd basically would use majority of my diversified cash in Roth and High Interest Savings for emergency fund in case I get laid off.

Question 1: Should I use my available cash or apply for a heloc?

Question 2: If I use a heloc, does that replace my current loan with a higher rate? What are the drawbacks?

Question 3: What are the first steps I need to take to get the right financing in place if I use heloc? I'm assuming if using my cash is better option, I would just start applying for an FHA loan with the lowest rates.

Thank you!

[Michael Garofalo]

Hey Maggie,

I think in this case, I would try and work with a bank that would allow you to get pre-approved for both an additional primary (1st) mortgage (using your cash as a down payment) as well as taking out HELOC on your existing property, just to have it available for future use. The bank will ask for pretty much all same info when applying for primary mortgage as it will for a HELOC, so why go through that process twice?

The advantages of obtaining a HELOC would be low closing costs and an increased channel for liquidity, whereby you are only paying interest on what you need. If you don't draw down on it, you aren't paying for it (some banks do have a $50 or $100 fee per year to keep it open, but that's negligible). The biggest disadvantages of a HELOC is it could get frozen if the housing market goes down and home values drop, and it carries a variable interest rate which can go up at any time.

A HELOC would sit behind your first mortgage (they are normally 2nd position liens), which means you are not replacing your current loan, you are just adding an additional one and would be responsible for making 2 different payments each month for that specific property. The amount the bank will lend is typically between 80-90% LTV. As a simple example, if your house is worth $100k, and the bank is willing to do 80% LTV, then 80k would be your starting point. If you owe $50k in principal on your first (primary) mortgage, then your HELOC would be $30k in available credit. During the draw period, you can withdraw funds, pay down the line, and repeat as much as you'd like. It's basically a low-interest credit card.

Sorry if that is confusing  and too much info, but feel free to PM me if you'd like more details or have further questions!